THE FINANCIAL CRISIS : SECURITIES

Fed plan unlikely to ease state's credit crunch

Lockyer won't count on U.S. loans as California prepares to offer billions in IOUs.

SACRAMENTO — A new federal program designed to ease credit by purchasing short-term business debt probably won't be available to California and other beleaguered state and local governments, Treasurer Bill Lockyer said Wednesday.

Although the New York Federal Reserve Bank hasn't ruled out helping agencies sell tax-free bonds, Lockyer said the Commercial Paper Funding Facility set up this week by the government to help corporations hobbled by the credit crunch was unlikely to provide any assistance to municipal bond issuers.

"I'm saying, gee, you need to adjust the scope of the program so it includes municipal commercial paper," Lockyer said. "We have a problem, and we don't know how you can care about business and not care about state and local government."

If the IOUs don't sell, the state could run out of money to pay for many routine expenses by month's end.

To underscore the importance of the upcoming sale, Gov. Arnold Schwarzenegger will appear in advertisements set to air on Los Angeles and San Francisco news-radio stations beginning Thursday. The governor is urging individual Californians to invest in their state by buying the notes during a retail sales period Tuesday and Wednesday.

The notes will be available for purchase by commercial and institutional investors Oct. 16, and sales are scheduled to close Oct. 23.

Lockyer and Schwarzenegger say the state needs to borrow as much as $7 billion to cover routine expenses and smooth out cash flows until tax receipts arrive in strength early next year. The $7 billion might not be enough if revenues continue to fall below estimates.

On Wednesday, the Schwarzenegger administration reported the 2008-09 budget the governor signed just two weeks ago already was $3 billion in the hole.

Schwarzengger says he plans to meet with legislative leaders on a weekly basis to "make sure we have the money to pay back" any loans.

Andrew Williams, a spokesman for the New York Fed, declined to discuss the state requests in any detail. The bank, he said, is "consulting with bond dealers and issuers on the parameters of the program, and a lot of the details are to be finalized."

Lockyer said New York Fed officials cited legal issues involved with backing state tax-free bonds as possible impediments to including local governments in the commercial paper purchase plan. The treasurer, however, said he disagreed and stressed that there was no reason the U.S. government couldn't buy the state notes.

The Fed also might be worried that if it began to lend money to California and other high-profile states, it could set a precedent for bailing out all 64,000 issuers of municipal debt, said Matt Fabian, a principal at Municipal Market Advisors, an independent research and consulting firm in Concord, Mass.

"It sets up a potentially unsustainable demand from other issuers," Fabian said.

Last week, Schwarzenegger sent a letter to U.S. Treasury Secretary Henry M. Paulson, warning that a lack of buyers for California securities could force him to ask the federal government for as much as $7 billion in short-term loans.

In Washington, a spokesman for House Speaker Nancy Pelosi (D-San Francisco) said the powerful lawmaker was in close contact with both the Schwarzenegger administration and the Treasury.

"The freeze in the credit markets is preventing states from meeting their routine, short-term funding needs, and that is why the Bush administration should strongly consider California's request or explain clearly why it would reject it," spokesman Nadeam Elshami said.

Selling billions of dollars' worth of bonds in the midst of a global credit freeze could be a challenge, municipal finance experts caution.

California is one of a number of states, local governments and public agencies that has had trouble finding buyers for bonds at what it considers reasonable rates of interest.

In recent weeks, Massachusetts had twice postponed a $750-million note offering but was finally able to make the sale Wednesday, eliminating the need to borrow from the federal government.

In California, the state-backed California Housing Finance Agency and a handful of school districts have put off bond sales rather than be forced to issue bonds with higher-than-expected yields.